SUSTAINABLE and responsible investing (SRI) looks set to make a long-term impact in the Malaysian capital markets. This is given the surge in the number of institutional investors that range from pension to international sovereign wealth funds subscribing to more sustainable or ethical forms of investing.

Such a trend is further spurred by the increasingly blurred distinction between shariah-compliant funds and socially responsible or environmental, social and governance (ESG) funds as both share very similar traits and attributes.

In fact, shariah-compliant investments are now widely considered a subset of ESG investing. From an investment perspective, the alignment of shariah funds and ESG funds is positive as more ethical investments would be implemented and adopted, according to AIIMAN Asset Management (formerly known as Asian Islamic Investment Management) managing director Akmal Hassan.

“Thus, such securities will now command a broader appeal among investors who are into ethical investing or are impact investors,” he tells FocusM. “This will allow both shariah-compliant and ESG funds to grow concurrently as demand for both investments gain traction.”

Changing demographics

Akmal attributes such trend to changing demographics whereby the millennial generation tends to hold a very different world view, thus is generally more conscious about the wider challenges faced by mankind, including climate change, income disparity and inequality.

“As they enter the workforce and start holding key positions of power in deciding allocation of resources, they would tend to favour shariah-compliant or ESG funds,” he argues. “This will be a growth catalyst that leads to an increase in the size of assets under management for the sustainable and responsible investing market.”

In August last year, the Employees Provident Fund (EPF) scheme rolled out the Simpanan Shariah scheme as an option for members who wish to convert their EPF savings to one that is managed and invested in accordance with shariah principles.

The Securities Commission issues an updated list of shariah-compliant stocks twice a year based on the companies’ latest annual audited financial statements. The latest list which came into effect on Nov 24 features 686 shariah-compliant counters or 76% of the total 902 listed companies on Bursa Malaysia (33 newly-classified shariah-compliant securities are included while another 22 are excluded from the previous list issued in May).

Similarities and differences

RAM Consultancy Services Sdn Bhd CEO Chris Lee says that socially responsible funds have a larger pool of possible investments compared to their shariah-compliant counterparts given that the latter can only partake in shariah-compliant investments.

Lee stresses the need for market promoters to promote their offerings transparently by highlighting their relevance and value-add propositions to investors

Otherwise, the structure of both socially responsible and shariah-compliant funds are similar in terms of control and governance, eg fund manager, trustee and investment committee. In contrast, socially responsible funds can invest in both shariah and non-shariah compliant investments.

“The target investors for socially responsible and shariah-compliant funds overlaps,” he say. “However, their philosophy – except for the shariah factor – are consistent with each other.”

Very broadly, socially responsible funds target investors seeking to invest in only socially responsible companies and products, while shariah-compliant funds have a strong niche for those who are required to invest in only shariah-compliant companies and products.

In Lee’s observation, innovation in products and track record in generating returns are key to grow demand for both funds.

In Malaysia, shariah-compliant funds started as early as 1993 while socially responsible funds are a more recent development. In essence, the former has flourished together with the growth of the Islamic finance market where Malaysia is a global leader.

On the other hand, socially responsible funds are growing in tandem with the worldwide momentum for responsible investing spearheaded by the United Nations’ Principles for Responsible Investing.

To Akmal, some key distinctions between the two often relate to their core investment objectives, notably (i) socially responsible funds are businesses that strictly adhere to social, moral, and environmental beliefs, while (ii) shariah-compliant funds look into investments that comply with Islamic principles, ie investments must be free from riba (interest), gharar (speculation/uncertainty), maysir (gambling), and other non-halal elements (in addition to the debt levels and other financial ratios).

Fund performance

Lee stresses the need for market promoters to promote their offerings transparently by highlighting their relevance and value-add propositions to investors.

“They must be motivated in doing good for investors [as opposed to the amount of management fees they charge] by ensuring that they manage the funds responsibly and productively,” he asserts.

Lee foresees both shariah-compliant and socially responsible funds as having many new opportunities with the many new SRI sukuk (Islamic bond) coming on-stream. He deems renewable energy as sustainable with a good payback period while the transportation sector has opportunities to reduce carbon emissions and improve the quality of life for the urban population.

In Akmal’s view, shariah equities have been displaying their resilience globally with the S&P and Dow Jones shariah-compliant benchmarks both outperforming their conventional counterparts.

Both the Dow Jones Islamic Market World and S&P Global BMI Shariah Indices has over the one-year period (as of Nov 24) gained 25.31% and 24.99% respectively, outperforming the conventional S&P Global BMI by nearly 300 basis points. Leading gains in the respective index are information technology and healthcare stocks which tend to be overweight in Islamic indices.

Back home, the performance of shariah equities has, however, underperformed conventional equities. The performance of the FBM Shariah vs FBM Emas over a one-year period (as of Nov 24) is 7.05% vs 11.65% as the conventional side was led by banking stocks which performed well this year with the return of growth and pick-up seen in the economy (aside from construction and oil & gas stocks).

On the flip-side, shariah stocks performance was driven mainly by the manufacturing and technology stocks with selective mid-sized construction stocks pacing the index. Defensive sectors such as real estate investment trusts and telco had underperformed the market this year (but still held up well due to their attractive dividend yields).

Choosing the winners

THERE are other criteria aside from profit that determine the performance of shariah-compliant funds or socially responsible funds.

These include the quality of the fund manager, the available pool of investible assets and the cost of operations (including fees paid to fund managers, shariah advisers and trustee), among others.

One other factor not often factored in is the size of the fund which may have bearing on the economies of scale in operations, according to RAM Consultancy Services Sdn Bhd CEO Chris Lee.

“In the Malaysian context, the early funds regardless of conventional or shariah-compliant impose too much cost on investors,” he tells FocusM. “The higher management fee imposed reflects the small size of our fund industry which lacks economies of scale in the early days.”

Moreover, high agent fees work against the returns for investors. The modern trend is towards lower entry cost for investing in funds.

“There is research today that argues returns from exchange-traded funds (ETFs) can be superior to an actively-managed fund primarily because ETFs have a lower cost structure imposed on investors,” suggests Lee.

The sensible view is that it is a case-by-case and generalisation approach towards investing in funds may give investors different experiences. The “time” factor will also have a major bearing in measuring returns depending on when a fund is initiated and the corresponding time when returns are measured.

In the case of shariah-compliant funds, AIIMAN Asset Management (formerly known as Asian Islamic Investment Management) managing director Akmal Hassan stresses that investors need to understand that it is not a performance trade-off when making an investment into shariah-compliant products as their performance is comparatively on par with their conventional peers.

“It really boils down to the expertise of the respective fund managers; finding a fund manager who is able to provide an investment option that meets your needs would be key,” he points out. “In the end, the preference to pick shariah-compliant funds over conventional funds goes back to the investor’s own investment objectives and risk-profile.”